Equity Crowdfunding Must be a System of Value Creation

Paging through the weekend crowdfunding news, I was taken aback when I read that the CEOs of two major crowdfunding portals, Indiegogo & Fundable, both agree that “[equity crowdfunding] returns aren’t likely.” Slava Rubin, CEO of IndieGoGo, and Wil Shroter, CEO of Fundable, opined on the issue at the Empact Summit in Washington, DC. (1)

A bit later, Rubin went further and said that if his company ended up getting into crowdfunding to build equity in a company (as opposed to raising money for a project or a cause), he’d put the onus of warning of the dangers onto his own company. He’d have a cartoon with someone with their pockets empty show up every time someone invested as a way to show the potential pitfalls. “It will be like a cigarette pack that says ‘you will die.’ Instead, it would say ‘you will go broke,'” Rubin said.

The sentiment was shared by Wil Shroter, founder of Fundable, a crowdfunding platform for small businesses. People who invest in a business through crowdfunding and expect to see a return on that will be disappointed, but that doesn’t mean they’re victims of fraud.”Startups…mostly fail. The public needs to understand startups aren’t an easy investment,” Shroter said. “If everything goes extremely well. In seven years, you might get your investment back.”

For context: IndieGoGo is a pioneer of perk-based crowdfunding, and currently the second largest in the U.S. behind Kickstarter. They’re considering supporting equity crowdfunding post-JOBS (after raising a $15m Series A in June 2012, I find it hard to believe they won’t). Perk-based today, Fundable joins IndieGogo as one of the better capitalized and more experienced players in the equity-crowdfunding space. The founding team also operates the GoBigNetwork, a network that connects startups with accredited investors (comparable to Gust & AngelList), an asset they’ll surely leverage to bring deal flow and liquidity to Fundable.

This positions two highly reputable operators and thought leaders in the space as believing that equity crowdfunding for startups will notprovide a positive return on investment to investors.

I can’t make sense of this. If equity crowdfunding, on average over the long-term, is a losing financial proposition, the critics are right, it has no place in our economy. It will be nothing more than a mechanism for value destruction.

Patronage has its place in crowdfunding. Kickstarter, having raised over $315m to date for new projects, ideas and movements, exemplifies this. But when for-profit motivations take the wheel – as they will in equity crowdfunding – patronage must take a back seat. Startups are not helpless, underserved entities deserving of our charity. In fact, charity will only hurt them. They need disciplined capital; capital that expects a return. Capital that believes in them, supports them, but will also hold them accountable in their search for a job-generating, value-creating business model.

Equity crowdfunding cannot become Web 3.0’s incarnation of a roulette wheel, with the the odds ever against those who play. This would not be the heralded democratization of capital markets many, including myself, are witholding; it would be the democratization of a VC model that, in aggregate, has proven to be broken, and destructive to value. This surely would not be sustainable. And while accredited investors have the means to chin the losses this model delivers, non-accredited investors do not; even with the caps, losing $500, $1000, let alone $2000, in a year wouldn’t just be a minor speed bump…

But this doesn’t have to happen, and I don’t believe it will. The industry will innovate into models that support a system of net value. We’re seeing glimpses of this today. Companies such as CircleUp are leveraging experience and domain-expertise (Consumer Products/Retail) to offer more qualified deal-flow. CommunityLeader is developing a portfolio management product that will help investors diversify and manage crowdfunding investments. And GATE Technologies, who recently partnered with Crowdfunder, is developing a robust secondary-market trading platform for alternative assets – a platform that stands to reduce liquidity risk for investors. (2)

Through robust disclosure, great investor education, ancillary market services and products that will offer guidance and support, and innovative structural mechanisms developed by competitive portals, equity crowdfunding can be a system of value creation. It must be.

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About Jonathan Sandlund

Founder, TheCrowdCafe

http://twitter.com/jeffseedrs Jeff Lynn

I agree with you 100%, Jonathan. Equity crowdfunding only makes sense if there are positive returns, and I firmly believe there will be (I wouldn’t have co-founded Seedrs if I didn’t).

Early-stage/angel investing is a very profitable activity when done in a diversified manner — the historical data puts a 22% IRR on it in the UK and 26% in the United States — but the key is building a diversified portfolio. Platforms like Seedrs give investors the easiest possible way to construct a wide portfolio of startup investments, and they have the added benefit of the wisdom of the crowds in selecting which startups get investment — neither of which are present in off-line investing.

People who invest in only one or two startups through an equity crowdfunding platform absolutely will go broke. But those who invest in 50 will, I believe, see their investment outperform every other asset class available.

http://jsandlund.wpengine.com/ Jonathan Sandlund

Jeff,
Thanks for the input, much appreciated. Do you have publicly available data on the average investment size you’re seeing? My research pegs Crowdcube’s median investment size at ~$2500 (n=19) and Symbid’s at ~$500 (n=8). Although quite different platform dynamics are at play so its tough to compare. I imagine you’re seeing a number significantly lower? (Particularly for non-accredited investors if that’s being captured?)

http://www.assob.com.au/ Paul Niederer

Our experience on ASSOB, the world’s longest running equity based funding platform, is that for the past 100 raises the median investment is $300,000. 63% of this is provided by friends, family, fans and followers (the crowd) in other words unaccredited investors. This may be a high median to others but at the front end we have set the requirements fairly high and our in-house legal check out the entity, the people and the IP thoroughly. I like your use of the word patronage Jonathan. I’m sure there is an aspect to this though I wouldn’t know how large. My feel is that as the invested amount gets lower the level of patronage increases and there is a choice between patronage and a risk play by the investor.

http://jsandlund.wpengine.com/ Jonathan Sandlund

Paul – thanks for the data, much appreciated! I agree on the inverse relationship between patronage and investment size. And I think this relationship provides insight into how we can manage liquidity and transaction flow. Social motivations will bring a larger number of investors to the table, but I think financial motivations will be the tipping point for most fundraises.

Digressing to community crowdfunding. (Where I see debt making the most sense for existing SMBs.) Only 90% of accredited investors here in the U.S. currently invest in private companies. The infrastructure, angel networks, etc., just doesn’t exist in many non-metropolitan and geographically-disadvantages areas. But assuredly there is still wealth here – and crowdfunding can be this infrastructure. I think bringing these accredited investors – whose social motivations will bring out the checkbook, and financial motivations will add a 0 – off the sidelines will be key to liquidating the market. It’s not a stretch to see an investor, who has the means, to come in for $5-10,000 on a $100,000 fundraise for a local restaurant he/she loves.

http://www.assob.com.au/ Paul Niederer

Eventually got around to writing a blog post about patronage and equity crowdfunding.

Jonathan — I don’t have the exact figures in front of me, but our average investment size to date (including completed and non-completed deals) has been roughly £350. The median has held steady at £100, and the average gets increased by a few much larger investments. Our sample size is still too small to draw meaningful conclusions, though, and we’re waiting to publish a comprehensive set of data until we have a bigger pool to draw from.

http://jsandlund.wpengine.com/ Jonathan Sandlund

Jeff – this is great! Looking forward to the data set your team publishes once the sample size grows to a level of statistical significance.

Fascinating comments by Wil in that his customer base is largely the investor. Certainly the company is the beneficiary of capital and does pay the bill, but the investor is the source of the capital. If the customer value proposition — i.e., a return on investment — is not expected, why in the world would someone “buy”? Sort of like someone selling the proverbial “pet rock”. You buy it “just because”, with no expectation of value to be received — tangible or intangible. Maybe he views this as comparable to gambling — assume all monies spent will be lost. One can say the same for the venture industry, as per the Kauffman report. Very few firms produce the returns to warrant the risk profile of venture investing . And , they are not even playing with their own money, and are the “professional” investor. Think the crowdfunding space is a worthy endeavor — but understand it is not really anything new. Merely a technology application to facilitate capital formation — use a platform to aggregate capital in small amounts efficiently and broadly. A company I founded years ago did the same thing, but in larger sizes — $3mm to $20mm. Really this is a “digitizing” of the private placement process, which has historically been an “analog” practice. The narrative on CF from many imply that the companies funded will be very high risk — translated: early stage. That’s the risk, the nature of the underlying company, where it stands in its development cycle. Whether you raise money in a “digitized” or “analog” manner, the risk lies with the invested company. There will be platforms that focus on middle market companies, generally more financeable, having better sustainability than the early stage or start up company. Dismissing crowdfunding as a “no win or no expectation” proposition suggests that platforms will be teeing up deficient “products” that their customers won’t continuously buy in fear of not achieving the desired outcome. It is incumbent on the platforms to introduce companies that provide a value proposition long term, within the realm of the risk profile of venture or private investing.

Adam

Why no mention of dividend payments? Surely that’s an incentive and a way to generate additional income for investors. Equity crowdfunding leverages the long-tail of investments – smaller investments from many more individuals. For instance, had Facebook crowdfunded their $500k instead of going to Peter Thiel and you had put in $100, your investment at the height of the IPO ($44) would’ve been worth $1.4 million. Admittedly, a rare occurrence, but the potential is there. And I’d argue if you can’t afford to lose $100 on a failed startup, you shouldn’t be investing, right?

My opinion about the article is that it is true. But as creator of editorial projects bibliographic research through crowdfunding, also add to the article’s another question: Quality.

For example, for the subject to which I devote myself, is not the same present a project that contains no references, comments, grammar, spelling, and formarto context, duly developed. I also believe that in an editorial published in which there is little known or researched information, it is rather a replacement of an earlier published work.

These aspects of projects Literature, show quality measure is presented to the patronage reader. To a greater or lesser extent imfluye all the crowdfunding community and we are all part of it also as readers.

For example, to corroborate my comment, I quote my new crowdfunding project, a work of Publius Ovidius Naso, an original edition, the ancient background of National Library of Spain, and entitled: TRANSCRIPTION AND TRANSLATION OF THE BOOK OF 1502 BNE. That for details as mentioned in this comment, you can access the presentation at:

Another article on the issues that make a project is of quality for crowdfunding community, I believe it would be appropriate to publish as the second part of this, similarly to the creators of projects and for the patronage.

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